Banking StandardsWritten evidence from the British Bankers’ Association

1. The British Bankers’ Association (BBA) welcomes the opportunity to provide written evidence in connection with the pre-legislative scrutiny of the draft Financial Services (Banking Reform) Bill being undertaken by the Parliamentary Commission on Banking Standards. The BBA represents over 200 banks from 50 counties on international and domestic banking and financial services issues.

2. As the call for evidence observes, the main objectives for the draft Bill as set out in the “sound banking: delivering reform” policy document are to:

making banks better able to absorb losses;

making it easier and less costly to sort out banks that still get into trouble; and

curbing incentives for excessive risk taking.

3. We believe that when taken together with other financial stability measures currently being put in place that the recommendations of the Independent Commission on Banking now being enacted will result in the stated objectives being met. We are, in particular, strong proponents of the introduction of a statutory “bail-in” tool as a means of ensuring that creditors contribute to the cost of any resolution and see recovery and resolution planning as sitting at the heart of ensuring that no organisation be viewed as “too big to fail”. The capital measures and the retail ring-fencing set out within the draft Bill are both intended to strengthen these capabilities while maintaining diversity within the market place. This is in addition to significant changes to the UK regulatory framework involving a designated focus upon both prudential and conduct aspects of banking and financial services and the introduction of a macroprudential element to banking supervision to be overseen by the Financial Policy Committee,

4. We now turn to the detailed questions set out by the Commission and have noted the request that, where these questions relate to proposed secondary legislation that the Government has not yet published, the Commission would welcome views based on the Government’s stated intentions as set out in the accompanying policy document and the June White Paper “Banking reform: delivering stability and supporting a sustainable economy”. We have attached as appendix 1 our response to the White Paper as this sets out our position on a broad range of issues relating to the implementation of the ICB’s recommendations.1

Objectives and general approach

1. Does the draft Bill successfully give effect to the objectives set out in paragraph 1.3 of Sound banking: delivering reform and is it the most efficient and effective means of delivering those objectives?

5. As explained in paragraph 3, we consider the framework proposed within the draft Bill achieves the stated objectives.

2. Do any of the recommendations of the Independent Commission on Banking (ICB), which the draft Bill seeks to implement, need revision as a consequence of developments since the ICB’s report?

6. The draft Bill needs to be seen in the context of other initiatives including the advent of the Financial Conduct Authority and a firm signal of intent that misconduct will result in enforcement action and possible criminal sanction. We have also seen the recommendations of the Wheatley Review. We therefore consider that the measures contained in the draft Bill achieve what they set out to do without prejudging the outcome of the Commission’s inquiry into banking standards. There will, however, be need for consideration to be given to emerging EU and international initiatives as the Bill proceeds and the secondary legislation and regulation giving effect to the Bill’s provisions are prepared and finalised.

3. Do the powers in the draft Bill and the Government’s stated intentions for their use give effect to the ICB’s recommendations? Are any deviations justified?

7. The draft Bill follows the ICB’s recommendations closely with only limited deviations made in response to concerns raised during the consultation. Questions 16, 24 and 25 address these specifically.

4. What should be the timetable for implementation of these measures, and should it be set out more clearly?

8. The Government has we understand committed to the primary and secondary legislation being completed before the end of the current Parliament—scheduled for Spring 2015. The measures set out in the Bill, however, are complex and are also dependent upon PRA/FCA regulation and authorisation before implementation can take place. It would be helpful therefore to have a commitment from the regulatory authorities on the timetable for their completion of the relevant policy decisions and regulatory framework on a basis consistent with meeting the 2019 compliance deadline.

5. The draft Bill proposes continuity objectives on the PRA and FCA. Are these appropriate and compatible with their other objectives?

9. The continuity objectives are aimed at ensuring the continuity of core services from ring-fenced banks to their customer and would seem in keeping to us with both the purpose of ring-fencing and the other objectives of the two authorities.

Banking standards and competition

6. What will be the impact of the proposed changes in the draft Bill on banking standards in the UK more widely?

10. The reform process is an opportunity for banks to enhance and improve culture and standards, and to ensure that customers of both the ring-fenced and non-ring fenced bank are well served. Reform to incentive schemes, compliance mechanisms and a renewed focus on cultural expectations all have an important part to play alongside the structural benefits of ring fencing.

7. What will be the impact of the separation of retail and wholesale banking on the culture prevailing within each?

11. We believe that the ability of the different parts of a banking group to focus more on the maintenance of businesses focused upon the provision of services to specific and distinct core client groups will improve the ability of Boards to set clear directions for the restructured groups with respect to their expectations of how these businesses should operate.

8. What will be the impact of the ring-fence on competition, both in retail and investment banking, and in other areas of financial services?

12. It is arguable that the effective removal of the “implicit guarantee” will also level the competitive playing field. On the other hand, since the UK appears to be unique in requiring legal separation along the lines proposed UK banks impacted by the measures will face significant disruption and cost in the short term and will be placed on a different footing to many of their overseas peers. Those operating internationally will be impacted by more than one approach since different jurisdictions are each looking at structural issues separately.

Delegated powers and accountability

9. The draft Bill grants a large number of delegated powers to the Government. Are the principles under which delegated powers are to be exercised sufficiently clear?

13. The policy paper explains that the scope or “location” of the ring-fence is to be set in secondary legislation and the rules governing the legal, economic and operational independence or “height” of the ring-fence through existing regulatory powers. This would appear clear within the context of the ICB’s recommendations as set out in its final report though the issues to be addressed within these delegated powers are far from insignificant. The delegated powers also provide the means by which the Government can tie the loss absorbency aspects of the ICB’s recommendations into the implementation of the Recovery and Resolution Directive.

10. Does the scope of the delegated powers in the draft Bill represent an appropriate balance between flexibility for the Government to respond to changing conditions and accountability to Parliament and the public?

14. We believe the delegated powers provide the means by which the Government can respond to changing conditions and achieve an appropriate level of consistency with developing EU legislation such as the draft Recovery and Resolution Directive, CRD IV and possibly outputs from the Liikanen review. It is unclear however whether accountability to Parliament and the public for these arrangements are as strong as they need be. It is also important that draft secondary legislation is tabled while the primary legislation is being debated in Parliament—as currently envisaged—to ensure sufficient input into the legislative process from all interested parties. For example, if the threshold for the application of the ring-fence were lowered significantly, it would result in the measures applying to a wider number of firms, some of which may not be engaging fully with the process and possible implications for their business models.

11. Is there sufficient clarity about the Government’s intended use of delegated powers, both to enable public understanding and to enable affected banks to prepare for the proposed changes?

15. It would be helpful to have a clearer understanding of the way in which the Government envisages the delegated powers being used and the due process which this would involve.

12. The draft Bill provides for review of the ring-fencing rules by the PRA every five years. Does the proposed review mechanism provide sufficient accountability?

16. While a review clause is understandable, it would be preferable for the legislative provision to provide a commitment to consultation as part of the review though this may be implicit.

The ring-fence

13. Is the power to be able to exempt certain categories of deposit-taking firms from having to establish a ring-fenced bank appropriate, and on what basis should the conditions for exemption be set?

17. Basing ring-fencing requirements on larger deposit-taking firms would seem entirely in keeping with the ICB’s objectives for ring-fencing: financial stability, the continuous provision of core services and the ability to resolve in an orderly manner without putting taxpayer funds at risk.

14. Is the range of core and excluded activities defined in the draft Bill appropriate and sufficiently broad? Are the Government’s stated intentions for using powers to define further core and excluded activities appropriate?

18. The ICB ring-fencing model, set out in figure 3.6 on page 54 of its September 2011 final report, is intended to define the ring-fence through services being “mandated”, “prohibited” and “permitted”. As the ICB itself recognised, this involves a balance between losing synergies, and therefore increasing costs on the one hand, and the benefits of improving financial stability through separation on the other. There are however some complex issues involved. Further judgment is needed to determine the way forward where there appear internal inconsistencies in the ICB model. For instance, the ICB report indicated that trade finance should be a permitted activity whereas all services outside the EEA and services to financial institutions other than deposit-taking and payments are prohibited. As the policy document relates, a final decision has not yet been taken on whether ring-fenced banks should be able to provide direct trade finance services in support of their business customers.

19. Exclusion of dealing in investments as principal is expected and appropriate but requires clarification from the Government that they do not intend to prevent client intermediation, share dealing on behalf of customers and other activities that are not “proprietary” in nature using the bank’s own capital to generate trading returns for the institution.

15. Which categories, if any, of customer should be permitted to deposit with a non ring-fenced bank?

20. In addition to corporates and high net worth individuals, in responding to the Government White Paper the BBA explained that defining mandated services to SMEs on the basis of the lower size threshold would allow banks to locate the prime customer relationship from within or outside the ring-fence according to the complexity of their needs; this however would be entirely negated if larger SMEs remaining within the ring-fenced bank on a permitted basis were then denied direct access to services made available to smaller, mandated SME customers.

21. We further added that:

We would see a prima facie case for a subsidiary of a non-SME corporate group being able to opt out of the requirement that it can only deposit money with the ring-fenced part of a banking group if this meant that its banking services could not be integral to those provided to the rest of the corporate group. This would be consistent with the approach taken by the European Union which requires financial thresholds (and staffing levels) for “linked enterprises” to be taken into account when determining whether a particular firm is an SME. This however may be something that would in practice only arise infrequently since a corporate group would seem more likely to have a banking relationship spanning the ring-fenced divide—possibly through a corporate banking division that would encompass both the ring-fenced and non-ring-fenced part of the group (but be clear on behalf of which part of the group a legally contracted service was being provided from).

More difficult perhaps may be the question of a small but highly specialised company that may have a need for relatively complex financial product which the ring-fenced bank is prohibited from providing. We possibly see a case for an opt out since it is unclear to us that it has been established as a matter of fact that services can be provided on an agency basis from across the ring-fence divide on a competitive basis in the customer’s interest. Examples would include manufacturers with exposures to changes in commodity prices, haulage and distribution company exposures to changes in fuel prices and certain real estate partnerships or company linked ownership.

16. The Government is considering whether to allow ring-fenced banks to offer simple derivatives to their customers. Should they be allowed to? If so, what safeguards would be necessary?

22. Recognising that mis-selling constitutes a failure of financial conduct, we must also make sure that ring-fenced banks are in a position to provide the products and services which their customers need in the pursuit of their legitimate business. This includes the provision of hedging services and also trade finance. By definition, the processes supporting the provision of these products and services should be suitably robust.

17. Are the proposed corporate governance arrangements between the ring-fenced bank and the wider group sufficient to ensure the independence of the ring-fenced bank? Are these arrangements compatible with directors’ duties and principles of accountability?

23. The principles requiring the ring-fenced bank to be independent of the wider group and the directors of the ring-fenced bank to act principally according to their shared responsibility as a member of the independent Board of the ring-fenced bank are clear. However, further clarity needs to be provided as to the impacts of this independence on directors’ duties. It needs to be made expressly clear what duties are owed by the directors of a ring-fenced bank and to whom. This clarity is needed for there to be full and transparent accountability. The Government consultation on “Sanctions for the directors of failed banks” is also of relevance and our response is attached as Appendix 2.2

18. How appropriate are the proposed restrictions on exposures and operational dependencies between the ring-fenced bank and the rest of the group? Will these result in a sufficient degree of independence and resilience?

24. We have no difficulty with the principle that the relationship between a ring-fenced bank and other parts of a banking group should be on an arm’s length basis consistent with the independence of the ring-fence. We would be concerned however if the detailed rules resulted in the relationship between the ring-fenced bank and other parts of the banking group being subject to stricter demands than apply in the case of external third parties.

19. Will it be possible to effectively monitor and police the ring-fence, given the degree of regulatory discretion the draft Bill proposes?

25. We see no reason why regulatory discretion should impede the ability of the authorities to maintain a keen eye on the operation of a bank’s ring-fence and therefore see the balance between statutory provision and regulation more as a matter of exercising the more appropriate legal tool.

20. How effective will the provisions on corporate governance for ring-fenced banks be in promoting a wider improvement of standards? Should other measures also be considered?

26. As explained above, the reform process is an opportunity for banks to enhance and improve culture and standards, and to ensure that customers of both the ring-fenced and non-ring fenced bank are well served.

27. It is also being introduced within a regulatory framework in which a more intrusive approach is envisaged on both the prudential and conduct side and firmer efforts are made by banks themselves to improve the governance processes around risk and compliance. There is we believe a further case for initiatives in support of raising professional standards.

Depositor preference

21. Is the proposal to prefer insured deposits in the event of a bank insolvency justified? Is there a case for broadening the scope of deposits which benefit from this protection?

28. The financial crisis showed the importance of deposit guarantee schemes and for the protection they afford to be set at a suitably high level. In the UK this currently stands at £85,000 and the banking industry stands behind this. Depositor preference, however, gives customers no added protection and instead increases substantially the losses of other creditors—particularly those holding bail-in instruments—in the event of a bank going into resolution. Depositor preference has the potential to put the new capital regime out of balance particularly if the UK proceeds and the EU does not. It is therefore unclear whether the Government has given sufficient consideration to the consequences for bank funding (and the ability of others to invest in UK bank bail-in debt instruments) if the UK adopts a course of action which differs from the final Recovery and Resolution Directive. The prospect of the EU moving towards the partial pre-funding of deposit guarantee schemes also needs to be considered in the context of UK/EU coordination. We would suggest, therefore, that depositor protection backed by an obligation upon the part of industry towards a deposit guarantee scheme strikes the right balance between the need to protect depositors and the need for a consistent regulatory regime.

Capital levels

22. Does the draft Bill adequately implement the ICB’s recommendations on loss absorbency requirements?

29. While the draft Bill is in keeping with the ICB’s recommendations, it needs also to be borne in mind that the ICB recognised the need for the UK capital regime to be based upon the same building blocks as those being developed by the EU institutions. Accepting the higher requirements of the ICB, notably for UK ring-fenced banks and UK-headquartered globally systemic important banks to be required to hold PLAC equivalent to 17% of RWAs, we believe that the UK regime should be based on the same fundamental definitions as those to be put in place by the Recovery and Resolution Directive.

23. The draft Bill gives the Government power to direct the way in which the regulators can implement loss-absorbency requirements. How appropriate and well-designed is this power?

30. We are strongly of the view that the UK regime needs to be defined within the terms of the Recovery and Recovery Directive. Delegating implementation of the loss-absorbing requirements to the regulatory authorities provides the means by which the Government can stick to its timetable for putting the legislative framework in place and reflect the fact that the Recovery and Resolution Directive is not yet finalised.

24. Is the Government’s stated intention for the design of loss-absorbency requirements workable? Will it provide a sufficiently well-capitalised banking system? In particular, how justified is the intention to allow an exemption for assets held in overseas operations?

31. As matters stand, the intended design for PLAC is not consistent with the proposed bail-in tool proposed under the Recovery and Resolution Directive in that the Government considers that PLAC should be based on regulatory capital and subordinated debt and senior unsecured debt with a twelve month term remaining whereas the RRD is premised upon a one month cut-off. . There is also a difference between the Government proposing an RWA-based threshold for PLAC and the RRD proposing a gross liabilities based threshold for bail-inable liabilities, although the RRD rapporteur has proposed an amendment in favour of an RWA-based measure. While there is an open debate as to which definition which is the most appropriate the imperative is for the UK to align to the commonly agreed EU definition.

32. Turning to overseas operations, the policy document explains that the Government does not believe it is appropriate to set PLAC requirements against RWAs held in non-EEA operations of UK-headquartered banks providing they pose no threat to UK or EU financial stability. This strikes us as the right approach since placing major additional capital requirements upon global institutions purely by virtue of their domicile would have been disproportionate and additionally have unduly disadvantaged their competitiveness. Requiring additional capital against non-EEA operations would also not appear necessary when viewed against the objectives of the ring-fence including the need to insulate the taxpayer from the cost of ensuring the continuity of core services which do not include non-EEA operations.

25. Is the Government justified in its decision not to implement the ICB recommendation for a higher leverage ratio than is required by Basel III?

33. The concern with increasing the leverage ratio to a level higher than that required by Basel III is that for low risk asset portfolios it results in the leverage ratio being a determining factor in the amount of business written as opposed to being the backstop as Basel envisaged. This, for instance, has the potential effect of requiring banks (and building societies) with low-risk mortgage books to adopt a less prudent approach. We do not believe this to have been the intention of the ICB.


26. Will the UK authorities have the necessary tools and powers (as a result of this legislation and other initiatives) to be able to resolve a large failing ring-fenced or non-ring-fenced bank, while maintaining financial stability and minimising the risk to public funds?

34. When taken together with the special resolution regime already in place and the extension in scope to be introduced under the current Financial Services Bill, the UK authorities we believe will be well placed to bring about an orderly resolution. For large banking groups, however, this may depend upon cross-border cooperation, which explains our preference for proceeding through international agreement upon a commonly defined approach.

27. What is your assessment of the Government’s preferred design of “bail-in” powers needed to improve bank resolution? How likely is it that the Recovery and Resolution Directive will deliver effective bail-in powers?

35. We believe that there is a growing appreciation across the European Union of the role to be played by recovery and resolution planning and the part to be played by “bail-in” capital. We are therefore confident of agreement on the directive being reached and view it as imperative that the UK bail-in regime sits squarely within the EU model.

Impact assessment

28. Is the impact assessment of the costs and benefits credible and balanced?

36. We are less confident than the Government that the aggregate private cost to the UK banks of depositor preference would be in the range of only £0.3–£0.7 billion per year in the event that this involved the UK diverging from the framework adopted across the EU upon the finalisation of the Recovery and Resolution Directive.

29. Might there be any other unintended consequences which have not been considered?

37. Our comments on bail-in debt and depositor preference apply.

International issues

30. What will be the impact of the proposals on the international competitiveness of UK banks?

38. Our biggest concern would be if the Government proceeded with depositor preference and others declined. This would have the potential to substantially disadvantage the ability of UK banks to issue bail-in capital and would as far as we are concerned work against the broader financial stability objectives of the measures in the draft Bill.

31. Are the proposals consistent with existing and forthcoming international and EU regulatory initiatives, for example the recent Liikanen Report? To what extent are they likely to be superseded or generate conflicts?

39. The Liikanen Report drew a substantially different conclusion to the ICB in that the recommendation is for a limited form of separation—which may or may not end up being adopted—and further structural separation in the event of banking supervisors not being content with the robustness of an individual banking group’s recovery and resolution planning. In proceeding with domestic legislation on the timetable envisaged there is a need for the UK authorities to be confident that their approach will be sufficiently consistent with any subsequent European regime. As much of a concern would be if the UK approach differed significantly in terms of the capital measures including for the issuance of bail-in debt.


32. What other matters should the Commission take into account?

40. As ring fencing will inevitably involve the transfer of customers between entities, we welcome the Government’s intent, in Clause 5 of the draft Bill, to amend Part VII FSMA, which is the main legislative method currently available in the UK for transfers of banking business without the need for customer consent. However we have some concerns about whether Clause 5 would effectively address the shortcomings of Part VII:

(a)It is not entirely clear from the current draft of the amendment to section 106 FSMA as to whether the new category of Part VII transfer would still require there to be an element of deposit-taking. We assume this is not the case but would welcome early clarification.

(b)Part VII does not extend to businesses or assets held by any subsidiaries of a UK authorised person who has permission to carry on one or more core activities. For example, this could preclude separation and transfer of funding programmes within a subsidiary. The amendments to s106 FSMA in the draft Bill do not contemplate the business of subsidiaries of a ring-fenced bank.

(c)The Part VII process seeks to balance the interests of the transferor and stakeholders through a court process. This process is inherently uncertain. More analysis should be undertaken as to whether the court process is the right one in light of the ring-fencing policy, or should be modified to avoid that inherent uncertainty. As an example, there is no certainty under Part VII as to how the court will use its ancillary powers to make provision for issues which will be necessary for successful transfer (such as overriding change of control consents, termination rights under contracts, ratings downgrade provisions) but which potentially affect the rights of third parties.

41. We note also that the amendment to Part VII FSMA does not (and clearly could not) solve the issue of separation of businesses held in overseas subsidiaries and branches where individual customer and counterparty consents may be required. To this end we would hope that the UK regulator would reach out to its overseas counterparty regulators to ask for their cooperation when banks approach them to discuss the impacts in the relevant jurisdiction and offer assistance where required.

31 October 2012

1 Appendix not printed.

2 Appendix not printed.

Prepared 2nd January 2013